The last mile of the Bank of Canada’s drive to get inflation back to its two per cent target will be the hardest. Governor Tiff Macklem will be knee-deep in contradictory data, suggesting the timing of interest-rate cuts will be a judgment call. That means monetary policy could make an uncertain environment even moreso.  

Policy isn’t always this hard. When year-over-year changes in the consumer price index escaped the central bank’s comfort zone in April 2021, and then proceeded to climb all the way to 8.1 per cent in June 2022, the central bank’s leaders knew exactly what they had to do. Macklem initiated one of the most aggressive series of rate hikes in history, highlighted by a one-percentage-point increase in July 2022. 

Macklem is getting closer to where he thinks he needs to be. In his final speech of 2023, he said he expected 2024 will be a transitional year, implying that interest rates have peaked and that the central bank’s main task now is deciding when to cut them. “Once Governing Council is assured that we are clearly on a path back to price stability, we will be considering whether we can lower our policy interest rate,” he told an audience assembled by the Canadian Club Toronto. 

The Bank of Canada has a checklist of the things it will be watching: evidence that “core inflation” isn’t stuck at elevated levels, the balance between supply and demand, the public’s expectation of where inflation is headed, wage growth and corporate pricing behaviour. 

Only one of those items argues in favour of an interest-rate cut. That’s the balance between supply and demand, which you might also think of as economic growth. Gross domestic product declined in the third quarter, and there’s little reason to expect a rebound anytime soon because Macklem’s interest-rate increases are only now starting to squeeze demand enough to allow supply to catch up. Full-time employment dropped in December, a classic sign employers are finding it harder to maintain profit margins. 

Weaker growth has slowed inflation. Statistics Canada reported Tuesday that year-over-year increases in the consumer price index averaged 3.9 per cent in 2023 compared with 6.8 per cent in 2022. That’s a big improvement, and probably explains why some investors got excited about interest-rate cuts at the end of last year. But it’s still a long way from the two-per-cent target, which Macklem has vowed to hit no matter what. The months ahead could test his resolve.  

Average hourly wages rose 5.4 per cent in December, according to Statistics Canada. That’s helping households make up for the blow they suffered when inflation surged after the pandemic, but it’s also inherently inflationary because employers will seek to recoup higher wage bills by charging higher prices. Wage growth that’s faster than productivity growth risks stoking inflation because it squeezes margins, and Canadian labour productivity has been negative for two years. The central bank won’t be seeking negative wage growth, but it will have to drop significantly from where it is now for Macklem to begin cutting interest rates. 

There’s a maxim that the cure for inflation is more inflation: higher prices eventually destroy demand, forcing companies to cut prices. The Bank of Canada has learned that it’s probably more complicated than that, which is why policymakers are paying closer attention to pricing decisions within companies. 

When inflation took off, policymakers assumed competition would help contain cost pressures—there were supposed to be limits to what companies can charge without alienating customers, and it was understood that managers disliked making frequent price changes. 

But as deputy governor Nicolas Vincent showed in a speech in October, that’s not what happened in the aftermath of the pandemic. With inflation everywhere, consumers surrendered and paid the price. Companies, under margin pressures of their own, took full advantage. Some still are. The Bank of Canada’s latest quarterly Business Outlook Survey showed that some 37 per cent of respondents said the size of their price changes would be “greater than normal” over the next 12 months, down from about 43 per cent the previous quarter, but still more than before the pandemic. “Firms’ pricing behaviour is slowly returning to normal,” the report said. 

The shift might be too slow for consumers to notice. A separate Bank of Canada survey showed consumers thought inflation was 5.9 per cent in the fourth quarter, even though it ended the year at 3.4 per cent, according to Statistics Canada. They said they thought inflation would drop to about 4.9 per cent in 12 months and about four per cent in two years. Since expectations of inflation can become a self-fulfilling prophecy, numbers like that could prompt the central bank to resist interest-rate cuts to show it’s serious about anchoring inflation at two per cent. 

Core inflation might be the most important item on the Bank of Canada’s checklist. The central bank’s target is year-over-year changes in the consumer price index, but it has always relied on variations of the index that attempt to control for volatile items, such as oil and food. Excluding gasoline, the index grew 3.5 per cent in December from a year earlier, while the Bank of Canada’s two preferred measures of core inflation also exceeded the headline number by a similar amount.   

If core is a compass for where inflation is headed, then the Bank of Canada has little choice but to stick with higher for longer. The central bank’s next policy decision is Jan. 24. Anyone betting on an interest-rate cut as early as the spring should prepare to be disappointed. 

Kevin Carmichael is The Logic’s economics columnist and editor-at-large. He has spent more than two decades covering economics, business and finance for outlets including Bloomberg News, The Globe and Mail and the Financial Post, where he also served as editor-in-chief.